Deregulation as crony capitalism

Jesse of Jesse’s Café Américain posted on the important subject of deregulation in his last post, “Why the Austrian, Keynesian, Marxist, Monetarist, and Neo-Liberal Economists Are All Wrong.” In it, he opined that it is entirely wrong-headed to assume everything will be alright if we just let free markets work their magic. I want to take his thoughts one step further because I think there is a misperception about what the free market entails and why the deregulation movement went astray.

Kleptocracy defined

First, a framework.

Last March, I posted an article called “A populist interpretation of the latest Boom-Bust cycle” in which I used Jared’ Diamond’s viewpoint of stratified societies as Kleptocracies as a lens through which to understand the secular trends which have characterized the last generation of western economic history.

To review, Diamond won a Pulitzer Prize in 1998 for his book Guns, Germ and Steel, which is a narrative of how Eurasian societies as a whole have dominated others throughout the last 10,000-odd years.  One of his basic premises is that Eurasian societies are stratified, and hence less egalitarian, allowing individuals to specialize. The hierarchy and specialization have combined to give these societies advantages that less stratified (and less resource-rich) societies do not have.

The corollary of this – and where I want to concentrate – is that advanced societies are not egalitarian. Some will de facto have more, and others will have less.  Moreover, as Diamond asserts, this lack of equality becomes, in essence, a kleptocracy i.e. a reverse Robin Hood organization where the elites enrich themselves at the expense of the others.

This has been the reality in all advanced societies based on agriculture, manufacturing and services for the last 10,000-odd years. This social structure has been net beneficial to the societies employing it in comparison to more simple societies – a case of a rising tide lifting all boats. So, on some level, kleptocracy is nothing about which to get irate.

The problem is that not all kleptocracies are created equal. At some point, the ruling class overreaches in a way that subtracts from rather than adds to the overall prosperity of the society. Cries of “throw the bums out” are heard, an uprising ensues and a new elite is installed who themselves turn to the same methods of kleptocracy to ensure their own power.

I suggest you read my ‘populist’ post or Diamond’s book in full for more on this.  His book is quite enlightening.

Where free market ideology fits in

Obviously, if some always have more power and wealth than others, there is never a situation in which the economic playing field is level. Moreover, it is axiomatic that those with the means and access will always have greater influence over government than those without. So, in a very real sense, the socioeconomic elite of any advanced, stratified society will always  have disproportionate control of the economic and political system.

Now, I happen to be a Libertarian-minded individual, so I have nothing against the free markets or the concept of limited government and deregulation.  Freer markets and more limited government are my preferred ideal. However, I am a realist. I understand that markets are never truly free and government fulfils a necessary function.

So, when you hear someone talking about getting government out of the way and allowing the free markets to work, you should be thinking about the influence and control this would naturally engender.

Think crony capitalism

In fact, I would argue that the deregulation and free market capitalism that these individuals refer to is really crony capitalism in disguise. I will explain.

When I think of deregulation, I think of two related but distinct concepts.  The one is the actual de-regulation, which is the permission of economic actors to compete in markets previously unavailable to them by order of legislation or de facto government intervention and coercion.  The other is regulatory oversight, which is the maintenance of specific rules of engagement under threat of penalty on economic actors by government. De-regulation and regulatory oversight are related concepts but they are not the same.

I am a proponent of deregulation – a major reason I don’t see the re-imposition of the Glass-Steagall Act as the solution to what ails us.  When you look across industries that have been deregulated, from energy to transportation to finance, invariably competition has increased and prices have come down, benefitting consumers. That is what deregulation is supposed to do.

On the other hand, whenever you have witnessed lax regulatory oversight after deregulation, it has always been an unmitigated disaster (examples include finance in Sweden, the US and the UK, air travel in the US, energy markets in the US). De-regulation and lax oversight make for a particularly potent cocktail. It’s like allowing your twenty-year old and his friends to drink beer at home under your supervision, but then telling him he can raid the liquor cabinet when you go away for a week-long vacation.  What do you think is going to happen?

But, if you mix a lack of oversight with deregulation knowing that the political and economic playing field is not even, you are inviting corruption aka crony capitalism. Why do you think the Washington Post was trying to sell access to politicians on health care reform? Why was Lloyd Blankfein the only CEO in the room when AIG’s fate was being decided? Why did the Obama Administration make a secret deal with the pharmaceutical lobby on health care? You might answer that these examples show isolated cases of crony capitalism in an age of special interests. I would argue that you are just seeing the kleptocracy pendulum swing too far. This type of cosy relationship between government and industry has always existed. This is the reason a codified and robust structure for regulatory oversight exists – to prevent this type of thing from tilting the playing field too far.

So, if you want to boil this post down into a sound bite, think: deregulation good, but regulatory oversight necessary. Without the necessary check on the power of special interests that adequate regulatory oversight provides, deregulation is simply another word for crony capitalism.

  1. doctorx says

    Well done!

    The long form posts such as this IMO should be used more often. It gives you and other bloggers a chance to be heard with more subtlety.

    You and I happen to disagree re investment banking and commercial banking being separate, but I agree with virtually everything else you said here.

    1. Edward Harrison says

      Thanks DoctoRx, I have immense respect for your views. I know about your disagreement on the Glass-Steagall thing. I would say that it is one way to go that is not objectionable. But, there are many ways to skin a cat.

      Expect a follow-up to this at some point.

      1. doctorx says

        Thanks for your kind comments, Ed.

        Please call me Larry.

  2. Wag the Dog says

    There is still the open question of where to draw the line though. Obviously one cannot deregulate completely and leave nothing for the regulatory body to actually apply any oversight. The problem is that regulations without oversight becomes a deception for those market players not fortunate enough to possess the connections that would allow them to see what is really going on. Small investors get fooled into thinking they are buying financial products that meet some minimal standard set and enforced by a governmental body, when really they’ve been conned into buying financial instruments that will blow up in their face because the minimum standards are a lie. It is better to remove any regulation for which there is no corresponding enforcement body that has the required teeth. This way the smaller players can see what they’re getting up front. However I doubt that a perfect matching of deregulation and oversight (assuming consensus for such an agreement is even possible) will be able to prevent huge swinging boom/bust cycles entirely — regulatory bodies are no more the all knowing oracles, reflecting all information available to market participants, than the free market is.

    1. Edward Harrison says

      Wap the dog, I agree with your sentiments. There’s no sense in having a
      regulation unless you put teeth into the regulation behind it. I have said
      before that we don’t need a whole new set of regulations until we start
      actually enforcing the existing ones. There are laws on the books to
      prevent predatory lending. There were rules in place to stop excessive
      leverage. There were procedures in place to end risky lending.

      But regulators felt ‘a light touch’ was the right approach. Now we see the
      folly in that.

      1. Anonymous says

        Well I wouldn’t put my hopes in the regulators Edward. The regulators are not the answer as it is already obvious. Securities Ratings Agencies, which there is three of them, rated this bad financial instruments as AAA. Also, overleveraging was promoted by Basel Accords, internationally, and leverage increased systematically over the years. Of course the entire global economy was overleveraged. Full reserve banking is the solution. Fractional reserves are well liked by the inflationist who believe they are God with the economy.

  3. Anonymous says

    I write on corruption, which is my favourite research topic as a geographer; I wish I could tell you how many times I’ve written on the myth of the free market, and made exactly the points you make here, but coming at the topic from a different point of view. One particular theme you might like to look at is the actor-network theory of financial services corruption, which I have an article coming out on soon.

  4. Jules says

    As Reagan said, “trust, but verify.”

  5. Anonymous says

    Well actually, despite being an anarchist I have to support the Glass-Steagall regulation. Here is why. Fractional reserve banking system embezzles money, and have a lot of government support such as FDIC, and Fannie Mae & Freddie for example. There is no free market in the banking system for the simple reason that there is no free market forces to keep banking running optimally against risk. Just like the natural law of gravity. People don’t jump off of 4 story buildings, because they know they can die. If not, then it’s a miracle. Free market operates very much similar way. Bankers need to understand that failure is an option, and excess risk is not rewarded. I don’t believe in a mixed economy, because mixed economy is distortionary for the market players. Nobody cares about their money when they desposit into these fractional institutions. They believe they always get their money back, because of the FDIC, and government gurantees. Fannie, and Freddie, with these fancy financial instruments made it easy for Wall Street to sell with government guarantees. Relaxed lending standards was a result of failure not being a concern. Banks knew they will get bailed out if they got in trouble, so they didn’t really care about risk. In a free market, where the public is concerned about their business with their bank on a intimate level, whether depositing money, risk assessment, capitalizations, etc, you have banks having to please their customers, or you can get a bank run, or something in that nature. Bankers would be managing risk, and their reputation much better, but when you remove risk, you are inviting disaster. If you are going to deregulate banking, it has to be 100%, not 50%, or if not, don’t deregulate at all. Personally, I rather have the government abolish fractional reserve banking, and only allow full reserve banking, but the inflationist don’t like this.

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